1. Field of the Invention
The invention relates generally to the evaluation of an option spread based upon a sequence of options received from an input device, and relates particularly to the determination of a type of option spread based upon a comparison of each option in the sequence of options with each other option in the sequence and the quantity assigned to each option.
2. Description of the Related Art
The term “option spread” is defined as a concurrent purchase and/or sale of multiple options.
The term “option” is defined as a single option contract. Each option has several properties, such as an optioncode, a contract, a strike, a callput, and a quantity, which will be defined below. Whenever two options share an optioncode, a contract, a strike, and a callput, the two options are the same. Each option has a defined structure as determined by the Exchange rules on which the option trades. The Exchange rules specify exercise style, such as American or European, expiration date, the underlying instrument that the option exercises into, and available strike prices.
An “optioncode” designates the option contract. For options on the futures, physical commodities, and swaps an optioncode is generally a two letter code designated by the Exchange on which the option trades. By way of explanation, “LO” designates New York Mercantile Exchange (“NYMex”) options on the price of NYMex Light Sweet Crude Oil futures, while “AO” designates NYMex options on the average price of NYMex Sweet Crude Oil futures.
A “contract” designates the exercise date for the option. Generally, options are listed by contract month and year. By way of explanation, “Z04” for an “LO” option refers to a December 2004 for a NYMex Light Sweet Crude Oil futures option. Technically speaking, a “Z04” option expires three days prior to the December Crude Oil futures last trading day in November of 2004. The following description lists the generally accepted month codes: “F” January, “G” February, “H” March, “J” April, “K” May, “M” June, “N” July, “Q” August, “U” September, “V” October, “X” November, and “Z”, as discussed herein above, December.
A “strike” designates the price at which the holder of an option may exercise the right to buy or sell the underlying asset. Generally, a trader packages an option spread with a single strike. The price differentials between the options determines the strike.
A “callput” designates whether the option is a “call option” or alternatively, a “put option.” The holder of a call option may, but is not obligated to, purchase the underlying asset at a designated strike of the option. The holder of a put option may, but is not obligated to, sell the underlying asset at a designated strike of the option.
“Quantity” designates the number of options to purchase, if the quantity is a positive number, or the number of options to sell, if the quantity is a negative number.
A description of the purchase of a single $38.00 crude oil call option (value=$1.20) follows. If a trader predicts that in the next three months the price of crude oil will increase, the trader purchases a $38.00 call option on crude oil at a strike of $1.20 (expiration date: three months). The standard crude oil option is for 1000 barrels, accordingly such option would cost $1.20/bbl*1000 bbls or $1,200. With this $38.00 option, the holder may purchase crude oil at $38.00 per barrel within the next three months no matter the market fluctuation in the price for crude oil. If the per barrel price of crude oil becomes more expensive, the holder profits. If the per barrel price of crude oil becomes less expensive, the $38.00 call option expires worthless. The buyer may not want to risk $1,200. If the buyer does not want to risk $1,200, instead the buyer may simultaneously buy and sell multiple call options for a lower monetary risk.
A description of the concurrent purchase of $38.00 call option (value=$1.20) and sell of a $42.00 call option (value=$0.65) follows. If the holder of a $4200 call option sells the $42.00 call option, while simultaneously purchasing a $38.00 call option, the user pays ($1.20−$0.65) or $0.55/bbl*1000 bbls equivalent to $550. However, in so doing, the holder of the $42.00 call option loses the potential profit if the price of oil exceeds $42.00 per barrel sometime in the next three months. This transaction is known as an “option spread.” Because this particular option spread pertains to the purchase and sell of a “call” spread, this particular option spread in known, more particularly, as a “call spread.” A description of various option spread names follows herein below.
It is typically much cheaper to trade options as a spread rather than purchasing options as outright trades. An outright trade would be the purchase of the $38.00 call option followed by the sale of the $42.00 call option. The first reason that spreads are cheaper than outright trades is that the trader does not have to give up the sale/purchase spread on each portion or in other words “leg” of the spread. In the previous example, the value of the $38.00 call option may have been $1.20, but the sale/purchase price may have been $1.16/$1.24. Likewise, the value of the $42.00 call option may have been $0.65, but the sale/purchase price may have been $0.62/$0.68. Purchasing the $38 call option for $1.24 and selling the $42 call option for $0.62 results in a total purchase price of ($1.24−$0.62) or $0.62//bbl*1000 bbls or $620. On the other hand, the spread value was ($1.20−$0.65) or $0.55 and may have been quoted as $0.53/$0.58. The user therefore could buy the spread for 0.58/bbl*1000 bbls, which is equivalent to $580, instead of $620, the price of an outright trade. Typically, spreads are quoted with tighter bid/ask prices due to the reduced risk involved in trading a spread.
In addition, the purchase of a spread rather than the purchase of options outright insulates the holder from risk. For example, a trader may purchase the $42 call option for $0.68/bbl*1000/bbl or $680 and sell the $38.00/$42.00 option spread at $0.53/bbl*1000/bbl or $530. But if the underlying price of crude oil fails at some point in time between the purchase of the $42 call option and the sale of the $38.99/$42.00 spread, the purchase price of the $38.00/$42.00 option spread will drop as well. Therefore, the holder will be forced to sell the $42.00 call option at an even lower bid price.
The ability of a trader to quickly and accurately determine the type of option spread trade and the price of an option spread is critical. In the past, traders required a physical paper trail to determine the option trade name and calculate the price. In addition in the past, traders would carry physical records of trade histories in order to maintain a record of information associated with a particular trade.
Until now, traders would print large numbers of pricing sheets to cover various pricing scenarios for the many listed options. As market conditions changed during the day, traders would print hundreds of pages to try to keep their prices and risk valuations accurate. Calculating an option spread meant looking at the prices of each option on these pieces of paper and doing the math in one's head or with a calculator. Such process often was marked by fairly high rates of error. As option spreads became more complicated, such as with three and four legged spreads, and markets started moving more unpredictably, these methods have become a hindrance to fast and accurate options market-making.
What is need is a real-time solution that quickly and accurately determines not only the type of option spread, but also its price, and other important investment information such as the delta, gamma, vega, theta, and implied volatility of the individual options. The real-time solution must deliver up-to-the minute data to traders on the exchange floor, thereby enabling traders to make faster, more accurate trades as well as minimizing trading risk and ensuring accurate trading positions.
It should be noted that the references cited and discussed in the description of this invention are provided merely to clarify the description of the invention. The recitation and/or discussion of these references is not an admission that any such reference is “prior art” to the invention described herein. All references cited and discussed in this specification are incorporated herein by reference in their entirety and to the same extent as if each reference was individually incorporated by reference.